Glossary

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Here’s a glossary of key terms and definitions related to derivatives:

  1. Derivative: A financial contract whose value is derived from an underlying asset, such as stocks, bonds, commodities, or currencies. Derivatives include options, futures, forwards, and swaps.
  2. Option: A derivative contract that gives the holder the right, but not the obligation, to buy (call option) or sell (put option) an underlying asset at a specified price (strike price) on or before a specified date (expiration date).
  3. Futures: A derivative contract that obligates the parties involved to buy or sell an underlying asset at a specified price (futures price) on a future date (expiration date). Futures are typically used for speculation or hedging against price fluctuations.
  4. Forward: A derivative contract that is similar to a futures contract, but traded over-the-counter (OTC) and not on a centralized exchange. Forwards are customized contracts that involve an obligation to buy or sell an underlying asset at a specified price on a future date.
  5. Swap: A derivative contract in which two parties agree to exchange cash flows or other financial instruments based on predetermined terms. Swaps are used for various purposes, including managing interest rate risks, currency risks, and credit risks.
  6. Strike price: Also known as exercise price, it is the price at which an option can be exercised to buy or sell the underlying asset.
  7. Expiration date: The date on which an option or futures contract expires, and the rights or obligations of the parties involved cease to exist.
  8. Long position: Holding a derivative contract that benefits from an increase in the price of the underlying asset. For example, holding a call option or being a buyer in a futures contract.
  9. Short position: Holding a derivative contract that benefits from a decrease in the price of the underlying asset. For example, holding a put option or being a seller in a futures contract.
  10. Margin: The amount of money or collateral required by a broker from a trader to cover potential losses in a derivatives trade.
  11. Hedging: Using derivatives to offset or reduce risks associated with changes in prices, interest rates, exchange rates, or other factors that may affect the value of an investment.
  12. Speculation: Taking a position in derivatives with the expectation of profiting from changes in prices, interest rates, exchange rates, or other factors without necessarily having an underlying investment or risk to hedge.
  13. Market maker: A participant in derivatives markets who provides liquidity by quoting bid and ask prices, and stands ready to buy or sell derivatives to other traders.
  14. Clearinghouse: An intermediary entity that acts as a central counterparty for derivative trades, clearing and settling transactions, managing risk, and ensuring the integrity of the market.
  15. Mark-to-market: The process of valuing derivatives positions based on current market prices or rates, and adjusting the margin requirements or collateral accordingly.
  16. Call option: A type of option contract that gives the holder the right, but not the obligation, to buy the underlying asset at a specified price (strike price) before the expiration date.
  17. Put option: A type of option contract that gives the holder the right, but not the obligation, to sell the underlying asset at a specified price (strike price) before the expiration date.
  18. In-the-money (ITM): Refers to an option that has intrinsic value, i.e., the option’s strike price is favorable compared to the current market price of the underlying asset. For call options, this means the market price is above the strike price, while for put options, it means the market price is below the strike price.
  19. Out-of-the-money (OTM): Refers to an option that has no intrinsic value, i.e., the option’s strike price is not favorable compared to the current market price of the underlying asset. For call options, this means the market price is below the strike price, while for put options, it means the market price is above the strike price.
  20. At-the-money (ATM): Refers to an option where the strike price is approximately equal to the current market price of the underlying asset.
  21. Delta: A measure of the sensitivity of the price of an option to changes in the price of the underlying asset. Delta ranges from 0 to 1 for call options (0 to -1 for put options), with higher values indicating a higher sensitivity to changes in the underlying asset’s price.
  22. Gamma: A measure of the rate of change of an option’s delta in relation to changes in the price of the underlying asset. Gamma reflects how quickly an option’s delta may change as the price of the underlying asset changes.
  23. Vega: A measure of the sensitivity of an option’s price to changes in implied volatility. Vega reflects how much an option’s price may change for each percentage point change in implied volatility.
  24. Theta: A measure of the time decay of an option’s price. Theta reflects how much an option’s price may decline with the passage of time, assuming all other factors remain constant.
  25. Settlement: The process of fulfilling the terms of a derivatives contract, typically involving the delivery of the underlying asset or cash settlement, depending on the type of contract.
  26. Contango: A situation in futures markets where the futures price of a commodity or financial instrument is higher than the expected future spot price. This can occur when the cost of carrying the underlying asset (e.g., storage costs, interest rates) is factored into the futures price.
  27. Backwardation: A situation in futures markets where the futures price of a commodity or financial instrument is lower than the expected future spot price. This can occur when the expected future spot price is higher than the current futures price, and market participants are willing to pay a premium to secure the asset at the lower futures price.
  28. Black-Scholes model: A mathematical model for valuing European-style options, named after its developers Fischer Black and Myron Scholes. The Black-Scholes model is widely used in options pricing and is based on assumptions such as a constant volatility, no dividends, and efficient markets.
  29. Margin call: A demand by a broker for additional funds or collateral from a trader to maintain the required margin level in a derivatives trade. Margin calls are typically triggered when the value of the position declines, and the trader’s equity falls below the required margin level.
  30. Counterparty risk: The risk that one party to a derivatives contract may fail to fulfill its obligations, resulting in financial loss to the other party. Counterparty risk can be managed through various methods such as collateralization, netting, and credit risk assessments.
  31. Clearinghouse: An entity that acts as an intermediary between buyers and sellers in a derivatives transaction, serving as the buyer to every seller and the seller to every buyer. Clearinghouses play a crucial role in mitigating counterparty risk by providing clearing services, such as margin requirements, trade confirmation, and settlement.
  32. Mark-to-market (MTM): The process of valuing a derivatives position at its current market price to determine the unrealized gains or losses. MTM is typically done on a daily basis for most derivatives contracts to reflect the current value of the position.
  33. Trading volume: The total number of contracts or units of a derivatives contract traded during a specified period, such as a day, week, or month. Trading volume is an important indicator of market liquidity and activity, as higher trading volumes typically indicate greater market participation and interest.
  34. Open interest: The total number of outstanding contracts or units of a derivatives contract that have not been closed or delivered. Open interest reflects the total number of contracts that are still active and can provide insight into the overall market sentiment and potential for future trading activity.
  35. Position limit: The maximum number of contracts or units of a derivatives contract that a trader or investor is allowed to hold or control. Position limits are established by regulatory authorities to prevent excessive speculation or concentration of risk in the derivatives market.
  36. Market maker: A participant in the derivatives market who provides liquidity by constantly quoting both buy and sell prices for a particular contract. Market makers play a crucial role in maintaining market liquidity and facilitating trading activity.
  37. Spread: The difference between the bid price (the price at which a trader is willing to buy) and the ask price (the price at which a trader is willing to sell) of a derivatives contract. Spreads can provide insights into market conditions, liquidity, and transaction costs.
  38. Basis point: A unit of measure used in financial markets to represent one-hundredth of a percentage point. Basis points are commonly used to express changes in interest rates, yield spreads, and other financial variables.
  39. Contingent claim: A financial contract whose value depends on the occurrence or non-occurrence of a specified event. Derivatives contracts are often contingent claims, as their value is derived from the underlying asset’s price, interest rate, or other variables.
  40. OTC (Over-the-Counter): Refers to derivatives that are traded directly between parties outside of a centralized exchange. OTC derivatives are typically customized contracts that are negotiated and agreed upon by the parties involved, and they may involve higher counterparty risk compared to exchange-traded derivatives.
  41. Long position: Refers to a derivatives position where an investor or trader has bought or holds a contract with the expectation that its value will increase. The investor profits from a long position when the contract’s price rises.
  42. Short position: Refers to a derivatives position where an investor or trader has sold or written a contract with the expectation that its value will decrease. The investor profits from a short position when the contract’s price falls.
  43. Exercise price: Also known as the strike price, it refers to the pre-determined price at which the buyer of an options contract has the right to buy (in the case of a call option) or sell (in the case of a put option) the underlying asset. The exercise price is a critical component in determining the value and profitability of options contracts.
  44. Option premium: The price that the buyer of an options contract pays to the seller for the right to buy or sell the underlying asset at the exercise price. The option premium is influenced by various factors, including the current market price of the underlying asset, the time remaining until the contract’s expiration, and market volatility.
  45. Delta: A measure that represents the sensitivity of the price of an options contract to changes in the price of the underlying asset. Delta ranges from 0 to 1 for call options (indicating the change in the options price relative to a $1 change in the underlying asset’s price) and from -1 to 0 for put options (indicating the change in the options price relative to a $1 change in the underlying asset’s price).
  46. Gamma: A measure that represents the rate of change of an option’s delta relative to changes in the price of the underlying asset. Gamma provides insights into how sensitive an option’s delta is to changes in the underlying asset’s price and can impact the hedging strategies used by options traders.
  47. Theta: A measure that represents the time decay of an options contract. Theta measures the rate at which the value of an options contract erodes over time due to the passage of time, assuming all other factors remain constant. Theta is a critical factor to consider in options trading, as it impacts the profitability of options positions over time.
  48. Vega: A measure that represents the sensitivity of an options contract’s price to changes in market volatility. Vega measures the change in the options price for a 1% change in implied volatility, and it can impact the value of options positions as market volatility fluctuates.
  49. Rho: A measure that represents the sensitivity of an options contract’s price to changes in interest rates. Rho measures the change in the options price for a 1% change in interest rates, and it can impact the value of options positions as interest rates change.
  50. Volatility skew: Refers to the uneven distribution of implied volatility across different strike prices of options contracts. Volatility skew reflects the market’s perception of the probability of large price movements in the underlying asset and can impact the pricing and trading strategies of options contracts.
  51. Synthetic position: A combination of multiple derivatives contracts or positions that replicates the risk and return characteristics of another derivatives position. Synthetic positions are commonly used by traders and investors to achieve specific risk or return objectives using a combination of options, futures, and other derivatives.
  52. Arbitrage: The practice of taking advantage of price discrepancies between two or more markets to earn a risk-free profit. Derivatives arbitrage strategies involve exploiting price differences in related derivatives contracts or the underlying assets to capitalize on inefficiencies in the market.
  53. Black-Scholes model: A mathematical model used to calculate the theoretical price of European-style options contracts. The Black-Scholes model takes into account various factors, including the current market price of the underlying asset, the exercise price of the option, the time remaining until expiration, the volatility of the underlying asset, and the risk-free interest rate. The model is widely used by options traders and investors to determine the fair value of options contracts and make informed trading decisions.
  54. Greeks: Refers to a set of measures used to assess the risk and sensitivity of options positions to changes in various factors, including the price of the underlying asset, time decay, volatility, and interest rates. The Greeks, including delta, gamma, theta, vega, and rho, are used by options traders to manage risk and optimize their options trading strategies.
  55. Clearinghouse: An intermediary organization that acts as a counterparty to both buyers and sellers in a derivatives transaction, ensuring the smooth settlement and clearing of trades. Clearinghouses play a crucial role in mitigating counterparty risk and ensuring the integrity and stability of the derivatives market.
  56. Margin: Refers to the collateral required by brokers or clearinghouses from traders or investors to cover potential losses in a derivatives position. Margin requirements are set by exchanges or clearinghouses and vary depending on the type of derivatives and the risk associated with the position. Margin is an essential element in managing leverage and risk in derivatives trading.
  57. Initial margin: The initial collateral or deposit required by brokers or clearinghouses when a trader or investor opens a derivatives position. Initial margin is typically a percentage of the total value of the derivatives position and serves as a safeguard against potential losses.
  58. Maintenance margin: The minimum level of collateral or deposit required to be maintained by traders or investors to keep a derivatives position open. If the value of the derivatives position falls below the maintenance margin level, the trader or investor may be required to deposit additional margin to bring the position back to the required level.
  59. Settlement: The process by which a derivatives contract is resolved, either through physical delivery of the underlying asset or through a cash settlement. Settlement terms and procedures vary depending on the type of derivatives and the specific contract specifications.
  60. Clearing: The process by which a derivatives transaction is confirmed, matched, and reconciled by a clearinghouse, which acts as a central counterparty between buyers and sellers. Clearing ensures the timely and efficient settlement of derivatives trades and helps mitigate counterparty risk.
  61. Counterparty risk: The risk that one of the parties involved in a derivatives transaction may default on their contractual obligations, leading to financial losses for the other party. Counterparty risk is an important consideration in derivatives trading, and measures such as margin requirements, collateral, and the use of clearinghouses are used to mitigate this risk.
  62. Mark-to-Market (MTM): The process of valuing a derivatives position based on the current market prices or other relevant pricing models. MTM allows traders and investors to determine the current value of their derivatives positions and assess their unrealized gains or losses.
  63. Settlement price: The price at which a derivatives contract is settled at the end of the trading day or at the expiration date. The settlement price is typically based on a reference price, such as the closing price of the underlying asset, and is used to determine the final cash settlement or physical delivery of the contract.
  64. Expiration date: The date on which a derivatives contract expires and ceases to exist. For options, the expiration date is the last day on which the option can be exercised or traded. For futures contracts, the expiration date is the date on which the contract must be settled.
  65. Exercise: The act of using an options contract to buy or sell the underlying asset at the specified strike price. Options can be exercised either through physical delivery (for physical-settled options) or through cash settlement (for cash-settled options).
  66. Assignment: The process by which the seller of an options contract is obligated to fulfill their contractual obligation to deliver the underlying asset (in the case of a call option) or purchase the underlying asset (in the case of a put option) if the buyer exercises the option.
  67. Hedging: The practice of using derivatives to offset or mitigate risks associated with changes in the price of an underlying asset. Hedging allows market participants to protect against potential losses or volatility in their existing investments or positions.
  68. Speculation: The practice of taking on risk in the hope of making a profit from anticipated price movements in derivatives or other financial instruments. Speculators in the derivatives market aim to profit from price changes and do not necessarily have an underlying investment to hedge.
  69. Arbitrage: The practice of taking advantage of price discrepancies between different markets, exchanges, or derivatives contracts to make a risk-free profit. Arbitrageurs exploit temporary price differences to buy low and sell high, profiting from market inefficiencies.
  70. Position: Refers to the overall exposure or holdings of a trader or investor in a particular derivatives contract or strategy. A position can be long (buying) or short (selling) and may involve multiple contracts or combinations of derivatives.
  71. Margin: The collateral or initial deposit required by a clearinghouse or broker from a trader or investor to enter into a derivatives transaction. Margin is typically calculated as a percentage of the total contract value and serves as a form of security or guarantee against potential losses.
  72. Margin call: A demand by a clearinghouse or broker for additional margin from a trader or investor when the value of their derivatives position falls below a certain threshold. Margin calls are used to ensure that traders have enough collateral to cover potential losses and may require additional funds or assets to be deposited.
  73. Notional value: The nominal or face value of a derivatives contract, which represents the underlying asset’s quantity or size. Notional value is used to calculate the contractual obligations and potential payouts of a derivatives contract, but it does not represent the actual amount invested or exchanged.
  74. Option premium: The price or cost of an options contract, also known as the option premium. Option premiums are determined by various factors, including the current market price of the underlying asset, the strike price, the time remaining until expiration, and the volatility of the underlying asset.
  75. Greeks: A set of risk measures used in options trading to assess the sensitivity of an options contract’s price to changes in the underlying asset’s price, time, volatility, and other factors. The Greeks, including delta, gamma, theta, vega, and rho, are used to manage and hedge options positions.
  76. Derivatives clearinghouse: An intermediary organization that acts as a central counterparty for derivatives transactions, serving as a buyer to every seller and a seller to every buyer. Clearinghouses provide clearing, settlement, and risk management services, helping to reduce counterparty risk and ensure smooth transaction processing.
  77. Over-the-counter (OTC) derivatives: Derivatives that are privately negotiated and traded directly between parties, rather than on a centralized exchange. OTC derivatives are customized contracts that are not standardized and are subject to bilateral agreements, making them more complex and less regulated than exchange-traded derivatives.
  78. Derivatives regulation: The set of rules, regulations, and guidelines governing the trading, clearing, and settlement of derivatives. Derivatives regulation aims to promote transparency, fairness, and stability in the derivatives market and may be enforced by regulatory authorities, exchanges, clearinghouses, or self-regulatory organizations.
  79. Clearinghouse margin model: The methodology used by a derivatives clearinghouse to calculate margin requirements for traders or investors. Clearinghouse margin models consider various risk factors, including market risk, credit risk, and liquidity risk, and determine the amount of collateral or margin required to cover potential losses.
  80. Derivatives market participants: The various entities that participate in the derivatives market, including individual traders, institutional investors, corporations, banks, hedge funds, market makers, and other financial institutions. Derivatives market participants may take on different roles, such as hedgers, speculators, arbitrageurs, or liquidity providers.
  81. Derivatives exchange: A centralized marketplace where standardized derivatives contracts are bought and sold. Derivatives exchanges provide a transparent and regulated environment for trading derivatives, with standardized contract specifications, pricing, and clearing mechanisms.
  82. Derivatives market liquidity: The ease with which derivatives contracts can be bought or sold without causing significant price movements or disruptions in the market. Liquidity is an important factor in derivatives trading, as it affects the ability to enter or exit positions, manage risk, and obtain favorable pricing.
  83. Contract specifications: The standardized terms and conditions of a derivatives contract, including the underlying asset, contract size, expiration date, strike price, and settlement method. Contract specifications are established by derivatives exchanges or clearinghouses and provide the framework for trading and clearing derivatives contracts.
  84. Settlement: The process of concluding a derivatives contract, either through physical delivery or cash settlement. Settlement methods vary depending on the type of derivatives contract, with physical delivery involving the actual transfer of the underlying asset and cash settlement involving the exchange of cash based on the contract’s value.
  85. Market risk: The risk of financial loss arising from changes in the market value of a derivatives position due to fluctuations in the price of the underlying asset, interest rates, or other market factors. Market risk is a fundamental risk in derivatives trading and can be managed through various risk management techniques, such as hedging, diversification, and stop-loss orders.
  86. Credit risk: The risk that one party to a derivatives contract may default on their contractual obligations, resulting in financial loss for the other party. Credit risk is a significant risk in derivatives trading, especially in OTC derivatives, and can be managed through measures such as credit checks, collateral requirements, and credit derivatives.
  87. Counterparty risk: The risk that a party to a derivatives contract may fail to fulfill their contractual obligations, resulting in financial loss for the other party. Counterparty risk is a key consideration in derivatives trading, and managing it involves assessing the creditworthiness and financial stability of counterparties, using clearinghouses or central counterparties, and implementing risk management techniques.
  88. Mark-to-market (MTM): The process of valuing a derivatives position based on its current market price, which determines the current profit or loss on the position. MTM is used to track the performance of derivatives positions in real-time and calculate margin requirements, collateral, and other financial obligations.
  89. Trading strategies: The various approaches and techniques used by traders and investors to profit from changes in derivatives prices or market conditions. Trading strategies can include speculative strategies, such as trend following, momentum trading, and mean reversion, as well as arbitrage strategies, volatility strategies, and others.
  90. Black-Scholes model: A widely used mathematical model for pricing European-style options, named after its creators Fisher Black and Myron Scholes. The Black-Scholes model is based on the assumption of efficient markets and provides a theoretical framework for valuing options based on factors such as the underlying asset’s price, time to expiration, strike price, volatility, and interest rates.
  91. Greeks: A set of measures used in options trading to assess the sensitivity of options prices to changes in various factors, such as the price of the underlying asset, time to expiration, volatility, and interest rates. The most common Greeks include delta, gamma, theta, vega, and rho, which help traders understand and manage the risks and potential rewards of options positions.
  92. Hedging: The use of derivatives to offset or mitigate the risks associated with an existing investment or position in another financial instrument. Hedging is a common risk management technique used by investors and corporations to protect against adverse price movements in the underlying asset or other market factors.
  93. Futures commission merchant (FCM): A registered intermediary that acts as an intermediary between traders and derivatives exchanges, facilitating the trading of futures contracts. FCMs are responsible for executing orders, clearing and settling trades, and managing margin requirements and collateral for their clients.
  94. Clearinghouse: A central counterparty (CCP) that acts as an intermediary between buyers and sellers of derivatives contracts, guaranteeing the performance of contracts and mitigating counterparty risk. Clearinghouses provide clearing, settlement, and risk management services, including margin requirements, collateral, and trade reconciliation.
  95. Margin: The amount of funds or collateral required by a derivatives exchange or clearinghouse to cover potential losses on open positions. Margin serves as a form of security or guarantee for the performance of derivatives contracts and is typically calculated based on factors such as the size of the position, market volatility, and risk parameters.
  96. Long position: The ownership of a derivative contract or security, such as an option or futures contract, with the expectation that its value will increase over time. Long positions are used for speculative or investment purposes, as well as for hedging existing positions.
  97. Short position: The sale of a derivative contract or security that is not owned, with the expectation that its value will decrease over time. Short positions are used for speculative purposes or to hedge against potential losses in other positions. Short selling involves borrowing the security or contract from another party and selling it with the obligation to buy it back at a later time to close the position.
  98. Margin call: A request by a derivatives exchange or clearinghouse for additional funds or collateral from a trader or investor to cover potential losses on open positions. Margin calls are triggered when the value of the open positions falls below a certain threshold, and traders are required to deposit additional funds or collateral to maintain the required margin levels.
  99. Settlement price: The final price used to settle a derivatives contract at expiration or when the contract is closed. Settlement prices are typically determined by the exchange or clearinghouse based on various factors, such as the prices of the underlying asset or a designated reference price.
  100. Trading volume: The total number of derivatives contracts or securities traded within a specified period of time, such as a day, week, or month. Trading volume is an important indicator of market activity and liquidity, and it can impact the pricing, execution, and performance of derivatives positions.
  101. Commodity: A raw material or primary agricultural product that is traded in derivatives markets, such as crude oil, gold, wheat, or coffee. Commodity derivatives allow investors and traders to gain exposure to price movements in these underlying physical assets without physically owning or possessing the physical asset itself.
  102. Collateral: Assets or funds provided as security by a borrower to a lender in a derivatives transaction. Collateral is used to mitigate credit risk and ensure the performance of obligations under a derivatives contract. It can be in the form of cash, securities, or other eligible assets that are pledged or deposited by the borrower.
  103. Mark-to-Market: The process of revaluing open derivatives positions to reflect changes in market prices or other factors. Mark-to-market is typically done on a daily basis, and it involves calculating the unrealized gains or losses on open positions, which may require additional margin or collateral to be deposited to maintain the required margin levels.
  104. Delivery: The process of transferring the underlying asset or physical settlement of a derivatives contract upon its expiration or exercise. Delivery is typically used in futures contracts, where physical delivery of the underlying asset may occur if the contract is held until expiration and not offset or closed out prior to expiration.
  105. EFP (Exchange for Physical): A transaction where a trader exchanges a futures contract for the underlying physical asset. EFPs allow traders to swap a futures position for the physical asset, which can be useful for managing delivery obligations or obtaining or delivering the physical asset in a more efficient manner.
  106. Exchange-traded derivatives: Derivatives contracts that are traded on organized exchanges, such as futures exchanges or options exchanges. Exchange-traded derivatives are standardized contracts with fixed contract specifications, including contract size, expiration dates, and exercise or settlement terms. They are typically subject to regulatory oversight and are cleared through a central clearinghouse.
  107. Over-the-counter (OTC) derivatives: Derivatives contracts that are privately negotiated and traded directly between parties, outside of organized exchanges. OTC derivatives are typically customized contracts that can be tailored to meet the specific needs of the parties involved, but they are not standardized like exchange-traded derivatives. OTC derivatives are subject to counterparty risk, as there is no central clearinghouse to guarantee the performance of the contracts.
  108. Basis risk: The risk that the relationship between the price of a derivative contract and the price of the underlying asset or reference benchmark may change over time. Basis risk can arise due to factors such as changes in market conditions, liquidity, or supply and demand dynamics, and it can impact the performance or effectiveness of derivatives positions or hedges.
  109. Trading platform: An electronic or online system that facilitates the trading of derivatives contracts. Trading platforms provide a marketplace for buyers and sellers to enter orders, execute trades, and manage positions. They can be operated by exchanges, brokers, or other financial institutions, and they may offer various types of derivatives, trading functionalities, and access to market data.
  110. Regulatory authorities: Government or industry bodies that oversee and regulate derivatives markets and participants to ensure compliance with applicable laws, regulations, and standards. Regulatory authorities may establish rules, licensing requirements, reporting obligations, and enforcement mechanisms to promote transparency, integrity, and stability in derivatives markets.

This glossary provides a quick reference for understanding the technical language used in derivatives trading. It’s important to familiarize oneself with these key terms and their definitions to effectively navigate the world of derivatives and communicate with other market participants.

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